Skip navigation
Ensuring a Safe and Sound Federal Banking System for All Americans Site Map | Text Size: S M L

BankNet

BankNet
Resources for bankers

Appeal of Shared National Credit (SNC)-(Fourth Quarter 2016)

Background

A participant bank appealed the special mention rating assigned to a revolving credit facility during the August 2016 SNC examination.

Discussion

The appeal asserted that the credit should be rated pass. The appeal argued that cash distributions included in the examiner-calculated fixed charge coverage ratio should not be considered fixed charges because the cash distributions are not mandatory or guaranteed. The appeal asserted that structural controls are sufficient to control cash distributions in excess of free cash flow, and that base case projections show that the company has sufficient free cash flow to repay total debt outstanding over a seven-year period.

Conclusion

An interagency appeals panel of three senior credit examiners agreed with the appeal and assigned a pass risk rating.

The appeals panel concluded that a pass rating is appropriate because actual and projected operating performance demonstrates the ability to repay total debt within a reasonable period. This assessment recognizes the stability of revenues supported by longer-term, fee-based contracts and the expectation that the company will continue to make large distributions. While leverage is expected to increase because the borrower plans to fund expansion capital expenditures with additional debt, the increase is considered manageable because current operating performance supports repayment of the increased debt load and because expansion efforts are expected to produce additional cash flow.

The appeals panel concluded that controls to limit distributions are weak, because the leverage covenant is the only means to limit excessive distributions. The absence of distribution restrictions provides the opportunity to expand leverage to the maximum allowable leverage covenant ratio through distributions, leaving no covenant headroom for an unforeseen decline in performance. When determining the risk rating, the appeals panel weighed the strength provided by the stability of revenues and repayment capacity against the potential impact of structural covenant weaknesses and concluded that a pass rating is appropriate.